Two Great Fund Managers on Sale

Tim Middleton, contributor to MSN Money, finds two funds run by legendary managers which are lagging the market-but that's a good thing, he claims.

Some really great mutual funds are on sale. And their lousy performance is exactly what makes them so appealing.

The very best mutual funds are practically guaranteed to underperform some of the time, for the same reason that they outperform most of the time: Their managers are smarter than other investors. Eventually the herd catches up with them, but it can take a while.

Investment company Litman/Gregory studied the performance of large-capitalization mutual funds from 1996 through 2005. Among the funds that outperformed their rivals for the entire ten years, more than 90% had lagged the field by at least two percentage points for three years.

When Christopher C. Davis posted this at Davis New York Venture's Web site last summer, his Davis New York Venture fund (NYVTX) was actually riding a seven-year high during which its annualized return of 5.7% had trounced the Standard & Poor's 500 Index's 1.7% gain.

The Davis fund has since gotten its comeuppance, finishing 2007 with a gain of just 5%, lagging 60% of its peers. The problem was the fund's huge overweighting of financial stocks, which account for more than one-third of assets. For generations, the Davis family has [had] a strong bent toward financials.

So the subprime-mortgage mess is dragging down this fund, which as of January 30th was down 6.1% this year. But Davis isn't about to rejigger his fund because it's unpopular. Turnover is about 5% a year, indicating an average holding period of 20 years.

Davis was Morningstar's domestic-equity fund manager of the year in 2005, but he's practically anonymous compared with Bill Miller, the manager of Legg Mason Value Trust (LMVTX). Miller finished 2005 having beaten the S&P 500 for 15 consecutive years and at his peak was managing $45 billion.
But in 2006 he trailed the market by nearly ten percentage points, and last year he trailed by more than 12 points, with his fund 6.7% in the red. Assets have shriveled to about $16.5 billion.

Miller is another very patient investor-his fund's annual turnover is 11%-who has been sideswiped by the subprime mess and the related slaughter in housing stocks. He's a maverick stock picker who defies categorization. Despite the word "value" in the fund's name, its largest position is in Amazon.com (NASDAQ: AMZN), which has a [trailing-12-months] price/earnings ratio of 66x.

Miller has reaped huge gains because he's been willing to take huge risks: this fund has nearly half its assets in just ten names. Miller has ignored energy and the materials sector. Indeed, he's completely out of step with other investors-and over the long term, that's the kind of manager to back.

If the cause [of poor performance] is that a manager's favorite stocks are suddenly unpopular, that's the market's problem, not the manager's. Unpopular stocks are the cheapest ones and therefore potentially the ones with the greatest opportunity to rise.